Stocks for cloud-computing companies, which sell software and services linked to remote data centers via the internet, have experienced a horrible start to 2022. While the Nasdaq Composite Index is down nearly 30% year to date, many cloud stocks have fallen much lower.
Take Snowflake (SNOW 1.09%), for example. The company went public in September 2020, when shares opened for trading at around $240, then rallied to near $400 within months. However, this year, Snowflake is down over 60%. So, the question is: Is now the time to buy?
Just how expensive is Snowflake?
Snowflake is a Software-as-a-Service (SaaS) vendor. The company provides cloud-based enterprise data warehouse (EDW) services to its customers. Snowflake's offerings allow businesses to see all their customers' data and attain valuable insights that might otherwise remain obscured.
The biggest knock on Snowflake is its valuation. Simply put, it's expensive -- very expensive. The company isn't fully profitable yet, so its price-to-earnings (P/E) ratio isn't the best metric. For companies that teeter on the edge of profitability, P/E ratios can be too volatile to prove useful. They can fluctuate between non-existence (if there are no profits, there is no P/E ratio) or ballooning into absurdity if profits are tiny.
By contrast, the price-to-sales (P/S) ratio is a steadier metric. Since sales, or revenues, are always positive, P/S ratios always exist. Therefore, P/S ratios allow investors to measure valuations between companies, even if some of those companies are unprofitable.
Snowflake boasted an astronomical P/S ratio of 183 shortly after going public. Since then, its average P/S ratio has hovered closer to 100, though that number has since significantly retreated, and now trades at a multiple of 33. That's still high, though, when compared to other cloud providers: Amazon's P/S ratio is 2.7, Oracle's is 4.5, and Microsoft's is 9.8.
But Wall Street analysts remain bullish. What gives?
Wall Street analysts think Snowflake is undervalued
As noted in the below chart, the average analyst price target for Snowflake is over $275, implying an upside of 110% from current levels.
Now, before we continue, a quick caveat. Analysts' price targets are famously suspect as an actual predictor of future stock price movements. Nevertheless, price targets are a signal, even if they only reflect market sentiment. So, while I'm skeptical about the size of the move Wall Street is predicting for Snowflake, I think the sentiment that Snowflake is undervalued is actually correct.
With $3.9 billion in cash and no net debt, the company is well capitalized; it also has positive free cash flow, boasting $57 million for the trailing 12 months. Despite the recent sell-off in the stock price, revenue and earnings estimates remain solid. If those estimates remain in place, its stock price should rise. Even if estimates come down slightly, Snowflake still appears undervalued relative to its growth rates.
Analysts expect Snowflake's revenue to grow 66% in 2023 and 55% in 2024, contributing to increases in earnings per share (EPS). Wall Street suspects that Snowflake's earnings will increase to $0.16 per share in 2023 and $0.38 by 2024. Those estimates are well above the company's most recent earnings results. For all of fiscal year 2022 (ending Jan. 31), Snowflake reported $0.01 in EPS. In the prior fiscal year, it reported a loss of $3.81.
Is Snowflake a buy?
Some say that buying a stock in a downtrend is like catching a falling knife; others say it's more like grabbing a chainsaw. Either way, one thing is for certain: Engaging with the market in a downturn can be painful, at least in the short term.
But Snowflake's business model will benefit from the long-term fundamental shift toward cloud computing -- even if cloud stocks aren't getting the love they deserve right now.